Highlights
- On-time payments on small personal loans can improve your credit.
- They can also help diversify your credit mix.
- Make on-time payments and other smart credit decisions to increase your score over time.
Finding out how much your credit score really matters is a hard blow. For me, it was my first apartment. About a dozen apartment applications got denied because I had yet to pay attention to my credit score, which sat at a meager 423 the first time I ever checked it.
One of the ways I started building my credit score was to get a personal loan. Some lenders even work with low-credit borrowers to offer financing for nearly any purpose, making personal loans a hassle-free way to boost your score.
How to Use a Personal Loan to Improve Your Credit Score
Diligently paying down a small, short-term loan gradually increases your credit score over time. And following these steps, you can potentially have the funds in your hand in a day or two.
1. Check Your Credit Score & Report
Knowing where your credit stands before you shop around for personal loans helps you narrow down your lender options. Get your three credit reports from AnnualCreditReport.com and use free services like Credit Karma and Credit Sesame to check your score. Many credit card companies also offer free credit scores with your credit card account.
If you notice any errors on your report, such as accounts you never opened or loans still listed that you paid off, take the time to dispute these errors. This involves contacting the credit bureaus (Experian, TransUnion, and Equifax) and explaining what the error is. If their investigation shows it was an error, they then remove it from your reports.
2. Analyze Your Credit Utilization
Your credit utilization is the amount of credit you’ve borrowed compared to your overall credit across all your accounts. Using a personal loan to consolidate credit card debt helps lower your credit utilization because you’re paying off your credit card balances with a single loan.
When you consolidate your credit card debt with a personal loan, you effectively reduce the overall revolving credit you owe. This debt reduction leads to a lower credit utilization ratio — a key factor credit bureaus consider when calculating your credit score.
3. Diversify Your Credit Mix if Necessary
Your credit score contains many factors, with your credit mix making up about 10% of the total score. If you just have a credit card or a student loan, adding a personal loan to the mix helps you diversify your credit profile.
Lenders care about your credit mix because paying off multiple different credit types shows responsible money management across the board. This makes you a better financial candidate in the future.
4. Shop Around (but Avoid Multiple Loan Applications)
Don’t go through the same bank you use for checking just because it’s convenient. Instead, explore all your options. Shop personal loan rates through loan marketplaces like Credible, which show you rates from multiple companies in one place without negatively impacting your credit.
From there, apply through the most promising option. Avoid submitting multiple loan applications because each lender does a hard credit pull to see your score. Too many inquiries at once drops your score.
5. Borrow Within Your Means
The key to using a personal loan successfully is to stick with an amount you can reasonably pay back. When I took out a personal loan, I stuck to just $500 (the cash I needed for a new set of tires on my car). This allowed me to keep my payments under $50 per month.
When you’re trying to raise your credit score, it’s not about how much you pay back. It’s just about making regular on-time payments. A small loan with small monthly payments you diligently pay every month contributes significantly to credit score improvement.
6. Build a Positive Payment History
Your payment history makes up the biggest chunk of your credit score, at 35%. If you continuously make on-time payments, lenders report this to the credit bureaus and your score goes up.
The best way to ensure you don’t miss payments is to use autopay to ensure you never miss a due date and your payment history stays positive.
7. Monitor Your Credit Score Progress
As you start to pay down your personal loan, keep an eye on your score. Download your preferred credit score monitoring app and check in occasionally to see if your score has gone up. If you’re making on-time payments regularly and have no other strikes on your credit, your score ticks up slowly.
As your score goes up, the financial products and services available to you increase and your chances of getting better loan terms in the future go up.
Final Word
A personal loan is easy to apply for and offers a variety of terms to choose from so you can fit payments into your budget. While they work for many borrowers, they’re far from the only option to build your credit. Those looking for an even safer option will like easy-to-manage credit-builder loans.
Secured credit cards also help you easily build credit and give you access to a continued line of credit rather than one lump sum. If you put your everyday spending on the card and pay it off regularly, you start building credit in months. No matter which method you choose, taking the time to work on your credit only benefits you down the line when you need financing.
